How to plan for a worst-case scenario

As many longtime GRS readers know, a few years ago I quit my job to become a full-time writer.

The decision to ditch a job and leap into self-employment always brings up a lot of big questions, like where to get health care and how to adjust to working alone.

But the biggest question on my mind was about income. What if I lost a major client and my income suddenly dropped?

While I was still weighing the pros and cons of a secure paycheck, I learned that right before I was hired there was a series of layoffs in another department. It shocked a lot of people who thought the company was a “safe” place to work.

It was then that I really understood that no job is guaranteed, not even my seemingly stable day job where 20-year employment anniversaries were common.

Don’t panicWhether your income comes from a few sources and fluctuates, or whether it’s steady and dependent on one company, you just never know when it might take a nosedive.

And sometimes it has nothing to do with your employment situation. Medical expenses can come out of nowhere and quickly escalate into the tens of thousands, or more. Several years ago, my friend lost all of his possessions in an apartment fire. We have no idea when disaster will strike.

But that doesn’t mean we should live in a state of panic. In fact, the worst thing anyone can do during periods of trouble is panic because it leads to poor decisions.

“I’ve known people who are so worried about not having money that they started selling assets before they really needed to,” says Bob Stammers, director of investor education at the CFA (Chartered Financial Analyst) Institute. “For instance, they take money out of their 401(k) prematurely, which really makes no sense. That’s the thing that you do when all else fails, and if you don’t do it, you don’t pay your mortgage and your house goes into foreclosure.”

And while taking money out of a 401(k) is bad, there are even worse options for the financially desperate, like taking out a payday loan at an insane interest rate or using credit cards like an emergency fund, digging the hole deeper and deeper.

Be the ant, not the grasshopperSo how do you stay calm when you’re worried about keeping the lights on? The key is to prepare before disaster strikes.

“I personally think the more disciplined that you can be about fiscal planning and budgeting, the better,” says Stammers. “Of course right now there are a lot of people who are worried about their employment situation. With the government saying that they may have to cut back on funding, a lot of government workers are probably thinking right now about their jobs. But I think everyone should have a plan. A lot of people have unexpected situations that affect their income, so it makes sense to know what to do if things go bad.”

So where do you start? Stammers says these five elements are key to weathering a financial storm:

Have an emergency fund in place. “I think three to six months of living expenses, with six being ideal,” he says. “It really depends on how much income you have to replace because the larger your income is generally the longer it takes you to find another position.” And if you have consumer debt, start with a small emergency fund of $500-$1000, pay off your debt, then finishing building your emergency fund.

Always be negotiating. You already know that when your car insurance is up for renewal, you should shop around and negotiate to get the best deal. And if disaster strikes, it’s even more critical to talk to your service providers. “A lot of people [are] unwilling to do this because it’s kind of embarrassing, it’s not fun,” says Stammers. “But it’s much better to go to your credit card company and be honest that you’re having trouble paying them, because once it’s sent to collections there’s nothing you can do. You’ve ruined your credit, and you still have to pay the bill.” Also, keep in mind that service providers want to hear from you. “Service providers want to keep their clients, especially when the client is only in a temporary situation,” says Stammers. “Very often you can negotiate either a reduction in service or reduction in cost.” For instance, you can reduce your limits on your insurance policies. “It’s not a great place to be, but hopefully we’re talking about a temporary situation,” says Stammers. “You have to weigh the insurance limits and costs against the fact that you don’t have income.” Another tip is to get your student loan payments deferred. “A lot of people don’t know you can do that,” he says. “As long as you’re unemployed, you can defer it.”

Tap your network. Stammers says that networking is something that everyone should be doing all the time. “The people who are networking all the time are the ones that tend to spend the least amount of time unemployed,” says Stammers. “That’s because the majority of jobs are found by networking, and a lot of jobs are filled before the opening is even announced.” In addition, if you lose your job, “you know who to call, you know where there might be opportunities and you won’t sound so desperate,” he says. If you aren’t networking now, Stammers recommends starting with your alma mater. “Find out if there’s a college networking event in your area,” he says. “I meet all sorts of people at those events, and it’s great because I already have something in common with them.” He also recommends checking out industry events and seminars.

Develop an income-producing side hobby. “I know people who turn down work all the time because they’re busy and because they’re comfortable,” says Stammers. “But this is one of the best ways to reduce the risk of losing income, because if you’re maintaining an extracurricular business, it’s easier to turn that up than to start it. It’s also going to take you time to build a client base.”

Create a basic austerity plan. List your regular expenses in order of what you can cut first. For instance, luxuries like eating out and going to the movies are one of the easiest things to cut quickly. But as you cut more and more, the decisions can get tough, which is why a plan is so important. “When you have to make harder and harder decisions, you’ll know what they are ahead of time,” says Stammers. “So if you’re unemployed and your wife is working, maybe you don’t need two cars, so you get rid of a car. You already know what to cut, so you aren’t making crazy decisions.”

Hopefully, you won’t ever need your emergency plan, but you might just sleep better at night knowing it’s there. “The idea is to reduce your risk as much as possible,” says Stammers, “and the way you do that is by planning ahead.”

I may be about to experiene a 1/3 cut in income. My health care employer is outsourcing some of our work and I do not know how drastically the changes will affect me.

I am adding to my emergency fund every pay and trying to attack my debt. I owe just over $19,000 on my HELOC and that will take 2 years to clear. If/when my hours are cut my debt payments will slow to a trickle as I look for a second job.

As important as it is to pay off consumer debt, I think it is even more important to build a real emergency fund. A paltry sum like $500 to $1000 won’t handle much of an emergency, like job loss. You can stop paying creditors if you lose your job, but you might have trouble coming up with cash for essentials. This is assuming you don’t have other substantial assets that you can tap if necessary.

I agree $500 is not nearly enough but I wouldn’t agree that you NEED a years salary in an emergency fund. If you are fueling your emergency fund to reach this amount, while still incurring debt, I think you are going about it the wrong way. Debt needs to be paid off, first. This way you avoid paying/losing money to interest. You should have some money set aside for emergencies like job loss, but every person is in a different financial situation and has different needs accordingly.

I think it is important to have an “emergency plan” AND an emergency fund. 3-6 months of expenses can be stretched. If I lost my job, I’d likely get 40 weeks of unemployment which would cover about 70% of my necessary expenses. So, for the first 10 months, I’d only use the first 3 months of the fund. Then I’d still have 3 months of emergency fund. And, my plan since I am single and childless would be to vastly decrease expenses- move in with friends or family, sell the car, etc.

If you have a 2 year fund I think you should probably invest 18 months worth in bonds or something low risk, but higher than savings account rates. You’d have plenty of time to turn it liquid if you found you needed it.

Seriously depends on what sort of debt you are dealing with. If you have something like a student loan or a mortgage at a low, fixed interest rate, then sure, just pay the minimum and focus on building up some cash. But if you are dealing with a high interest credit card debt, no, an emergency fund should NOT be your priority. I would view it as, that credit card debt is an emergency, so you are using the “emergency fund” to pay it down.

Also, I’m sorry, but a year’s worth of expenses sitting around in cash seems like overkill to me. If you seriously think you are likely to find yourself out of work for a year, it’s time to start exploring other lines of work…

I disagree. FIrst off, not everyone is able to predict with 100% accuracy when a job layoff or an emergency is going to happen. So if an emergency DOESN’T happen, then you’re wasting A LOT of money on interest.

Second, by paying off credit cards and other consumer debt, you’re making it easier to get more. For example, if you start to pay off your credit card, then disaster stikes, you now have more unused credit than if you never bothered paying the card. AND the amount you paid in interest is lower. Its not like “oh, you lost your job, now you must use cash for everything.”

I go back and forth on how much to save all the time. We have 12 months’ expenses saved, but then I’ll read a grim report on unemployment and think “Maybe we should try for 18 months?” But then I look at my mortgage statement and think “If I could just throw some extra cash at this, we could really reduce our principle and pay it off so much faster.” It’s so hard.

It all depends on your total financial picture. Are you a two income family and able to cover your monthly expenses and payments with just one person’s salary? You’ve probably got some cushion to have an emergency fund on the lower end of the spectrum. At the same time, if you’re making just above minimum wage and just barely scraping by, having a large emergency fund may not be feasible. If you’re somewhere in the middle of those pictures where you have the ability to really grow your fund that’s something that I’d recommend.

But as far as the debt/savings picture goes, I’d always recommend prioritizing building a comfortable emergency fund instead of paying more than the minimums on the debt. But what’s “comfortable” varies person to person.

Make sure that you have adequate insurance coverages as well. This includes disability insurance. Many people overlook this, thinking they are healthy and won’t ever use it, but for younger people, you are much more likely to get injured and not be able to work for a few months to year than you are of passing away.

Good point! I think many of us overlook this type of insurance because it’s included in our employee benefits packages. But it’s very hard to get disability insurance when you’re unemployed or self-employed.

A financial planner I consulted with recommends critical illness insurance as well. Having known otherwise healthy people who had strokes and cancer in their thirties and forties, I’m considering this kind of insurance too.

A friend of mine; married, early 30s, todler daughter, was shot in an attempted robbery the night before Thanksgiving. He had no disability ins. other than what he has through the union. He just got back to work a few weeks ago and even with the help of family and friends its been a real setback. This has been a eye opening experiance to say the least and a life changer for sure.
The Boy Scouts say to be prepared and Its a motto I live by. Try to always have a redundency or backup in all scenarios possable and have the tools or talents to fall back upon when the SHTF time comes. If it be cash in the bank or canned food in the root celler the rainy day fund is something we cant live without.

I totally agree. My disability insurance is what saved my butt when I became ill (qualifying illness). I never though I would need it when I signed up for it when I was 28 but I’m so glad I did when I needed it it at 30. Almost 4 years later its still paying off.

My son got Guillain-Barre’ syndrome at age 32. He was in the hospital for 5 weeks and off of work for 5 months. He had lots of therapies and worked really hard. Thankfully, he made a really good, complete recovery. My son had some union disability insurance, which certainly helped. A friend of the family also had this illness, and she had a year-long recovery.
So, you just never know about the future, do you?

Better than an income producing side hobby are income producing investments. All you really need is enough income to cover an austerity level of expenses and you’ve got your own insurance plan set up.

My financial emergency plan consists of building an emergency fund equivalent to one year’s worth of expenses. And aggressively growing income from my investments. I’m also dabbling in some potential areas of side income.

Having been through job losses and seen friends and family go through job losses, I know just how “secure” a full-time job can be. I’m grateful that my parents taught me to save for a rainy day, and a colleague of mine when I was an intern said to me: “In this industry, you really should set aside 6 months of expenses — anything can happen.”I’ve conducted a few financial fire drills in the past to see how my emergency plan holds.

I agree with other commenters — getting out and staying out of bad debt is a big part of having financial security. I’m facing some challenging times right now and I’m grateful I’m debt-free.

hello
Right now I am in emergency situation because I have no job atm. Fortunately I am not in debt at all and I have quite substantial savings AND my wife still works, so we are not losing money atm. Pretty comfortable situation
Best Regards

After feeling the effects of the recession on my family, security is my first objective. We’ve now paid off all of our debt, we live on about 22% of our salary, and we track our savings/spending to see how many years we could live off of it (over 9 years at the moment). We also have an “austerity” plan like the author mentioned, so we know how much we’d need to survive at a very basic level.

A few weeks ago there was a layoff at my husband’s employer and when he told me about it I immediately felt panicked. Then I remembered that we were ok, and it subsided.

Great article. I think all of your points are right on the money. The one thing I would add, in addition to knowing what expenses you can cut in emergency, is that already living well below your means gives you a big cushion should anything happen to your income. If you’re spending all of your income (or more), any drop in that income will put you in dire straits. But if you keep a nice cushion, a drop in income might not actually effect you much, if at all. Frugality, within reason, has many functions.

Great point, Matt! Life is much less stressful if you’re living below your means, especially if your income drops. My goal is to get our expenses to the point where one salary (mine or my husband’s) fully covers our set expenses. We’re close!

We often discuss what we would immediately cut if my husband were to lose his job. Bye bye all non-essentials like Roku/Hulu/Netflix, cell phone packages, eating out, etc. etc.

I know hypotheticals and reality are two different things, but we have watched lots of people get laid off and not do things that seem pretty elementary to me. Is there something I’m missing about the psychology of it all? Are people just loathe to change much or don’t see how to develop a bare bones lifestyle? Or do they think they will find a new job immediately?

I don’t want to judge too harshly, but I see this behavior fairly regularly, especially during the recession when so many lost their jobs.

We take great comfort in the fact that our mortgage and tax bill on our home are low enough ($800) that we could both work minimum wage jobs and still pay it. It wouldn’t be easy, but we could do it. Plus we have enough equity in the house that we could sell it and come out with a chunk of change if we needed to. We want to stay in this house forever, but if life changed, we could unload it if we had to.

I know many people who live in parts of the country that would balk at such a low mortgage payment, but even in our part of the country we could have bought a larger home and had a larger mortgage payment. The main reason we have stayed in our starter home and added on with HELOCs that we then pay off quickly is because we wanted a very low mortgage payment as a hedge against job loss. This was very calculated on our part and is the main part of our worst-case scenario plan.

I’ve seen this with quite a few people as well. I think for some people they may be in denial how bad things can get now that they are no longer employed.

Also post layoff depression is real and the thought of ‘staying at home staring at the wall, never going out, in between job hunting is more than what some people can handle.

I know I experienced that when I was single and out of work during all of 2005. There was no money to do anything with and I thought I was going to pluck my eyeballs out after 12 months of forced house arrest. I read every book I could get at the library and I ran every day but that wasn’t enough. There are low-cost activities but there aren’t many NO cost activities for adults.

Oh my goodness yes! Back in 2000-ish my roommate got laid off, and he remained unemployed for close to a year!

In the beginning he was hopeful that he could land another job, and he would do things like spend money on luxuries. I think he did that to take ths ting out of losing his job… Not fiscally sound at all, but probably a (not very good) way of emotionally coping.

As time went on it appeared to me that he spent his entire day playing video games, but I later found out that he was sending out resumes every single night. Right before he got a job he was very depressed.

So, even though someone appears to be taking the layoff lightly behind closed doors they may not, and they may be really suffering.

One problem I see with the side-income approach is that it can actually bring about the worst-case-scenario.

E.g., the side income might distract you from giving your best at your main occupation, and this could prevent you from becoming the indispensable worker who can’t be laid off, or the wildly successful entrepreneur or independent professional.

There’s a time for hedging, but there’s also a time to go all-in, and only you can assess your own risk/reward ratios.

If you want to prepare for a worst-case scenario have life insurance for everyone who’s funeral bills you’d be responsible for. It’s going to cost you at least $10,000 to bury someone. Hospital bills, even with good insurance, can quickly run to the thousands or tens of thousands of dollars for someone with a serious illness or who was in a serious accident. Anyone who is sick or injured incurs a loss not only of their *own* salary, but may very well require someone else to stay home to care for them, which costs that person’s salary as well. Your health insurance does not cover full-time in-home nursing care. If the sick person was primarily responsible for child care and can no longer do that, then you have to find someone to do that as well.

I agree. If somebody relies on you, then life insurance is important. People scoffed when my husband and I got life insurance because we are both somewhat young, healthy, don’t have kids and both have good jobs, but I don’t want him to worry if I die. We have enough life insurance that if either of us dies, our mortgage is paid off, our funeral expenses will be covered and the other person can take time off of work to grieve.

Tyler – and anyone else who is in the unfortunate and tragic position to know the answer – what would you suggest is a reasonable amount of life insurance for a stay at home spouse? And for a working spouse?

I just asked my husband what we have, and it’s $250,000 on the stay at home parent and $650,000 on the working parent.

Then, for example, maybe $10-15,000 per child per year until they’re five for full-time daycare.

Then maybe $5,000 per year from when they’re five until 12 or so for after-school daycare.

Then maybe $50,000 for paying off any end-of-life medical costs that you need to cover.

And enough to cover taxes.

Clearly, the child care costs are widely variable, and depend on your own children.

For a single 1-year-old child like I have, I would have liked to have had something like $150-200k in coverage. It would have made things a lot easier. $250,000 seems like a decent amount.

For the working parent, I would want enough to pay off *all* outstanding debts, *especially* a mortgage, and then maybe $25,000 post-tax living expenses for at least five years while the other parent has time to get back into the workforce and figure out how to do that with children. I would probably want $250,000 plus enough for debt plus taxes. I have $1,000,000 on myself, which seems about right here.

That’s very helpful. Thanks. We live in a pretty reasonable area of the country, so $650,000 would enable me to pay off the mortgage and (even factoring in health insurance) have a decent amount of time to get my bearings before I enter the job market full time. I think that’s what I most want for either my husband or myself – the time to regroup and grieve without worrying about bills.

My brother in law (who lost his wife in his 30s) did not have life insurance on his stay at home spouse, and he really could have used it. He didn’t have to pay for childcare for two kids, since he worked from home and had family help. But he nonetheless emerged from her illness with lots of debt. And this was with excellent insurance. The amount of co-pays and prescriptions were overwhelming. Plus they went on a homeopathic kick (in order to try to fight the cancer) that cost thousands upon thousands. And the cost of funerals take everyone, especially the young, by surprise.

You were right to bring up the true worst case scenarios in life.

loading....

25

Elizabethsays:

05 March 2013 at 12:26 pm

Every advisor I’ve talked to says it depends on the individual/family — i.e. how much income you need to replace and how much you’re willing to pay now for premiums. If your family relies on $150K of income per year, then your insurance needs are going to be higher than a family who lives on less.

I agree with Tyler that a job loss isn’t the worst case scenario — though these days it certainly seems to be the most likely. I don’t have anyone who is financially dependent on me so death isn’t even my worst case scenario. My worry is becoming disabled or critically ill.

This may be a little off subject but why do you think it costs $10,000 for a funeral? My son died 4 years ago and our total expenses, including a catered lunch for 60 people, were right around $3,200. We live in a relatively low cost of living area, but still, that’s a big difference.

Yes, he was cremated prior to visitation. There was no expense for a casket and since his ashes were to be buried next to his grandfather, we did not opt for a fancy urn. This isn’t for everybody, but it was perfect for him.

loading....

20

Tiarasays:

05 March 2013 at 11:32 am

Tyler, who speaks from experience, is exactly right. Major illness is a far greater risk than job loss. That’s why I have a big fat emergency fund at the bank. No, it is not earning much of a return, but I know it will be there when I need it. 2 years of living expenses sounds like a lot, but I know it could be drained quickly if disaster strikes.

So it really comes down to being prepared rather than panicking when disaster strikes. Have an emergency fun, know when certain contracts are up and if you should renew, and always be looking for different opportunities even if you won’t necessarily need to take advantage of one in the immediate foreseeable future.

As someone trying to get out of debt and find permanent work, I always go back and forth on paying off debt and my emergency fund. I have an EF that would get me by for 6+ mo and I live a very frugal lifestyle…it’s hard sometimes, when I just want to throw everything at debt, but having an EF is a necessity.

Excellent advice. When my husband suddenly lost his seemingly-stable job three years ago, we had both an emergency fund and an austerity plan in our files. We were able to quickly respond to our new situation, and it saved us a great deal of angst (as well as our finances.)

This is great advice. I wish that I had prepared myself previously with an income producing hobby. I also had not kept up with some of my contacts as well as I should have. Luckily, I had prepared myself financially with an emergency fund, but I have now been unmployed for an extended period of time.

Very good article and dead on the money – the hardest part for me is amassing the emergency fund that’s suggested; I’ve heard of these numbers before but they seem high. I think that a lower number would make sense as an emergency fund as long as you had a clearly planned out austerity plan or if the savings were based more on austerity than regular expenses.

Planning for the future is utmost important. Though we can talk of Austerity Plans, it would be highly difficult to cut costs, even by a small percentage. This is especially so, if you have kids. It is wise to earn more income by effectively using your network.

Until a year ago I maintained a separate emergency account with about a year’s worth of normal living expenses. I had to tap that to put on a new roof and properly redo a carport that had been closed in as an extra room decades before. Additionally, I had to treat for termites and lots of plumbing repairs. I had thought to rebuild that account at the expense of not funding for my retirement. Then I reevaluated my financial picture. I have no personal debt and my house is paid off. A significant portion of my retirement portfolio is allocated to short term treasuries and money market accounts. If necessary I could easily tap that to ride out a layoff or cover any other emergencies. As it stands there is still about three months of expenses in my emergency fund. Funny thing is there is still that part of me that wants to build that emergency fund back up to a year’s worth of expenses even though I am more than liquid enough to cover most forseeable events.

I lived a life along these lines for about four years. It never came to it, but I forced myself to have a date that I’d stop chasing it if it didn’t happen. I imagine this won’t work for all people; particularly those who can’t put their nose to the grindstone unless they burn the bridges behind them

Advertiser Disclosure:
Many of the savings offers appearing on this site are from advertisers from which this website receives compensation for being listed here.
This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). These offers do not represent all deposit accounts available.
Editorial Disclosure: This content is not provided or commissioned by the bank advertiser.
Opinions expressed here are author’s alone, not those of the bank advertiser, and have not been reviewed, approved or otherwise endorsed by the bank advertiser. This site may be compensated through the bank advertiser Affiliate Program.
UGC Disclosure: These responses are not provided or commissioned by the bank advertiser.
Responses have not been reviewed, approved or otherwise endorsed by the bank advertiser. It is not the bank advertiser's responsibility to ensure all posts and/or questions are answered.

Disclaimer: Rates / APY terms above are current as of the date indicated. These quotes are
from banks, credit unions and thrifts, some of which have paid for a link to
their website. Bank, thrift and credit union deposits are insured by the FDIC
or NCUA. Contact the bank for the terms and conditions that may apply to you.
Rates are subject to change without notice and may not be the same at all
branches.

Disclaimer:All information provided on this site is for informational purposes only. GetRichSlowly.org makes no representations as to the accuracy, completeness, suitability or validity of any information on this site and will not be liable for any errors or omissions in this information or any damages arising from its display or use.